We previously reported (Vol. I, No. 1, April, 2006) that a California Superior Court, in Northwest Energetic Services v. California Franchise Tax Board, had declared unconstitutional the fee imposed by Revenue and Taxation Code § 17942 on the gross income of limited liability companies. The basis for finding such fee unconstitutional was that it is applied to the world-wide income of all limited liability companies formed in California or formed elsewhere and qualified to do business in California. The failure to apportion the fee and apply it only to income from California sources could result in limited liability companies being subjected to duplicative taxation in multiple states on the same income. The Superior Court held that this violated both the Commerce Clause and the Due Process Clause of the United States Constitution. Northwest Energetic Services is still pending in the California Court of Appeals.
In September, Governor Schwarzenegger signed Assembly Bill No. 198 which revises § 17942 to limit the application of the fee to income from sources derived from or attributable to California. In the case of sales, they are assigned to California or another state using the same methodology used to determine the sales factor in the apportionment of the franchise tax on corporations. In addition, the Franchise Tax Board is authorized to aggregate multiple limited liability companies that are commonly controlled if it determines that the multiple companies were formed for the primary purpose of reducing the fees payable. Another positive aspect of the bill is that it clarifies that where a particular income item flows through multiple tiers of limited liability companies, it is subjected to the fee only a single time.
Finally, the bill addressed the many pending protective refund claims that have been filed. New Revenue and Taxation Code § 19394 provides that if the prior fee is ultimately determined to be unconstitutional, any refund to a taxpayer will be limited to that part of the fee paid that had been determined to be unconstitutional. In most cases, that would be the application of the fee to income generated outside of California. This means that limited liability companies whose only income is from California sources will not receive any refund.